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Going negative

The bank of Canada cut its key lending rate to 0.25 per cent this morning and pledged to keep it there for the next year or so. Although it seems like interest rates in the U.S. and Canada couldn’t go much lower, Harvard economist Greg Mankiw, says it may be time for the economic establishment to consider breaking new ground with “negative” interest rates. Under Mankiw’s proposal, an interest rate of, say, negative three per cent would make it so that borrowing $100 today would mean paying back $97 next year. It’s a clever proposal aimed at getting people to start spending again. But even Mankiw admits there’s a problem: Why would banks agree to hand out free money? That’s where central banks would have to get creative. Mankiw proposes two solutions: the central bank could choose a random number between zero and nine, and make all legal tender with a serial number ending with that number null and void; banks would therefore prefer to lend at minus three per cent rather than lose 10 per cent of their holdings. Or the Federal Reserve could push effective interest rates below zero by producing inflation; if people knew the dollars they borrow are worth way more now than they will be when it comes time to repay a loan, then it becomes worthwhile to borrow-and-spend rather than hoard cash.

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